Choosing Between a 401(k) Plan and a Traditional IRA

With the demise of traditional pension plans and the future of Social Security in doubt there has never been a more important time for individuals to seize the initiative of saving for their retirement. But with many different options to choose from, it is imperative that retirement money be invested wisely and with as many tax advantages as possible. Both 401(k) accounts and Individual Retirement Accounts (IRA) are important ways to save for retirement, but which to choose from. Here are some of the attributes of both 401(k) accounts and IRA's and how each can help you meet your retirement savings goals.

Funding your 401(k) account is the perhaps the most important investment step that you can make. Not only do many companies offer to match your contributions to these accounts, but 401(k) accounts have the important characteristic of being tax deferred, meaning that all interest and growth of principal is not taxed until the monies are withdrawn. In addition, all contributions used to fund the account are made with pre-tax dollars.
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Matching contributions typically are a percentage of the amount the employee contributes (for example 25%) or a percentage of annual salary (for example 3% of your annual salary is contributed to your account) with a cap at a certain amount (say $5,000). Meaning that if the employee contributes $10,000 to their 401(k) account for the year, the company will contribute $2,500 to the account as well. Or if your yearly income is $50,000, the company will contribute 3% of your salary, or $1,500. Read your companies' retirement plan carefully, as typically the company contribution will vest over several years of service.

Contributions to a 401(k) are made with pre tax dollars, meaning that all monies are made before they are subject to federal, state, unemployment, and disability taxes. That means that you are able to contribute a higher amount because your gross earnings have not yet been taxed.